Crisis-proofing the Philippine financial system
IT HAS BEEN MORE THAN A DECADE since the last global financial crisis. The 2008 crisis had started in the US subprime mortgage market, which crept into financial markets and led failing banks to either be rescued by governments or be closed down. However, the Philippine banking system was relatively insulated with bank failures contained within the rural banking sector whose small assets relative to the total sector’s resources posed little to no systemic risk.
Nevertheless, the Bangko Sentral ng Pilipinas (BSP) has been fortifying regulatory standards under the international Basel 3 framework since 2014 to ensure that the country’s financial system remains capable of weathering potential shocks that could spill over to the rest of the economy.
“At the height of the 2008 Global Financial Crisis, the BSP prudently considered opportunities for monetary policy easing and infusion of appropriate levels of liquidity amid the potential tightening of financial conditions. This in turn, helped maintain the efficient functioning of the financial markets and helped avert the shrinkage of domestic markets,” BSP Deputy Governor Chuchi G. Fonacier said in an e-mail.
Among these string of reforms include the 10% capital adequacy ratio (CAR), the 5% leverage ratio, and a framework for domestic systematically important banks (DSIBs) among others. The standards imposed by the BSP are well above the minimum standards of 8% for CAR and 3% for the leverage ratio set under the Basel 3 regime.
CAR indicates the banks’ ability to absorb losses from risk-weighted assets while the leverage ratio represents how much capital banks should have in hand to cover non-risk weighted assets.
These reforms will boost buffers maintained by big banks against potential risks, complementing the 6% common equity Tier 1 ratio and the 7.5% Tier 1 ratio imposed by the BSP.
Ms. Fonacier explained that since the impact of a financial crisis cannot be predicted, it would be difficult to identify precisely the indicators that would tell whether a bank is prepared for a financial crisis.
“[T]he BSP promotes a proactive approach and preemptive measures over the operations of BSP supervised financial institutions through adoption of risk-based supervision, principle-based policies and regulations, and appropriate supervisory measures,” she said.
The adoption of “macroprudential toolkit” such as bank stress test exercises also provides the BSP information to assess the overall health of the financial system as well as the individual banks that may encounter difficulty in times of distress, said Ms. Fonacier, who added that banks are expected to conduct to their own stress test exercises.
“Nonetheless, the BSP, under The New Central Bank Act (Republic Act No. 7653), may grant extraordinary loans or advances to banking institutions, secured by required assets, in periods of national and/or local emergency or of imminent financial panic which directly threaten monetary and banking stability,” said Ms. Fonacier.
“In particular, banking institutions may source liquidity support or avail the emergency loans and advances provided that the bank meets the conditions of access to these credit facilities and subject to the BSP’s procedure. Again, this assistance is available to all banking institutions provided conditions are met under the existing regulations.”
Another safeguard put in place is the requirement for banks to keep their real estate exposure to a maximum of 20% of their loan portfolio. This was introduced in the aftermath of the 1998 Asian financial crisis after banks were left with large soured assets in their books.
In addition to the real estate loan cap, the BSP issued tighter rules for real estate exposures in 2017 amid the double-digit credit growth in the sector. In particular, Circular 976 was issued in October 2017 requiring the reporting of more specific data on real estate loans covering mid- and high-end housing units, as well as socialized and low-cost housing. Data on commercial real estate loans in terms of specific structures being financed such as residential units, office, buildings, malls and factories are also to be included in regular reports required by the BSP.
The year before, the central bank has launched the residential real estate price index (RREPI) to monitor property prices and any looming property bubbles. The BSP collects RREPI data from the mandatory reports submitted by banks, which cover the amounts and profiles of the home loans which they hand out every quarter.
The BSP’s initiatives and procedures reflected an April 4 report of global debt watcher S&P Global Ratings wherein it stated that most economies in the Asia-Pacific region are more likely to provide “extraordinary government support” for big banks perceived as “too big to fail.” The Philippines is among the 14 out of 20 jurisdictions in the region that are “highly supportive” for too-big-to-fail banks.
A bank is considered “systematically important” if its distress or failure — because of its size — would disrupt the domestic financial system and threaten general economic activity.
Ms. Fonacier said that banks identified as DSIBs are subject to “more intensive supervisory measures and additional capital requirement including the adoption of a recovery plan.”
These intensive supervisory measures include, among others, the “greater intensity” of off-site and on-site supervision and monitoring, more frequent and in-depth assessment, “more intensive supervisory interaction and engagement” including between the BSP and the DSIB’s board, management and risk committee members, higher supervisory expectations on controls for significant operations, data aggregation and governance, and more “supervisory requirements” such as regulatory reports and other supplemental information.
“[B]anks identified as DSIBs are required to develop and maintain a concrete and reasonable recovery plan that sets out the actions that it will take to restore its viability in cases of significant deterioration of its financial condition in different scenarios. A component of the recovery plan is the identification of early warning indicators with specific levels that will trigger activation of the recovery plan even before the above-said breaches happen,” Ms. Fonacier explained.
BETTER EQUIPPED
Echoing the BSP’s assessment, banks are confident that the country’s financial system is well-equipped to weather external shocks.
“Much like during the financial crises in 1998 and 2008, the Philippine financial system as well as the overall economy remained stable, especially as local banks held relatively diverse portfolios, and in addition to risk mitigating measures imposed by the BSP during the period,” said Development Bank of the Philippines (DBP) President and Chief Executive Officer Emmanuel G. Herbosa.
“The stricter capital obligations are justified especially as banks were given sufficient time to adjust to the regulations and re-calibrate their strategies. Although capital buffers eat up resources otherwise made available to fund loans and investments, opportunity costs are offset as BSP continues to adjust policies to ensure sufficient market liquidity and support the growth of the Philippine finance market and the economy in general,” he added.
This view is shared by the Philippine National Bank (PNB): “Reduced profitability would be the price to pay for building up the banks’ capital buffer. However, the strong loan demand coupled with lower bank reserve ratio initiated by the BSP recently could partially compensate for the opportunity cost of the capital build-up, assuming the growth cycle remains upbeat and investment driven.”
For BDO Unibank, Inc., the central bank reforms have “definitely strengthened” the local banking system and is in line with global banking standards: “However, we need to strike the right balance between risk mitigation and long-term sustainability particularly access to capital to support growth.”
“Higher capital levels and regulatory costs compared to regional peers have made capital raising for Philippine banks more expensive due to their poor profitability.”
While the banks interviewed said they have put in place prudent credit policies and preemptive mechanisms in times of crisis, they remain confident of government support.
“Despite the fact the banks are better prepared to deal with stress situations, a systemic crisis (such as a liquidity crunch) is likely to generate significant risks for any banking system regardless of the strength of its balance sheets. Big banks, given their size and magnitude, have a material impact on the economy,” BDO said.
“We think some form of government support is forthcoming, but only as a last resort,” BDO said.
PNB was likewise confident: “The price to pay would be a sudden expansion of the budget deficit in a crisis scenario as the government comes to the rescue of those vulnerable to any crisis. With government debt ratios still low amid long debt maturities, the pressure on public finances in case of a larger social expenditure agenda during required during the crisis would not be as severe in our view,” PNB said.
For DBP’s Mr. Herbosa: “We believe our monetary authorities will act with wisdom and prudence if such crisis indeed occurs. We are confident, however, that the present dispensation has put enough safeguards that will avert such a crisis.” — Lourdes O. Pilar
